SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 26, 1997
Commission File No. 0-27742
CYLINK CORPORATION
(Exact name of registrant as specified in its charter)
California 95-3891600
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
910 Hermosa Court
Sunnyvale, California 94086
(Address of principal executive offices)
(408) 735-5800
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--------- ---------
As of November 6, 1997, there were 28,681,544 shares of the Registrant's Common
Stock outstanding.
<PAGE>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
CYLINK CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data; unaudited)
<CAPTION>
September 26, December 31,
1997 1996
--------- ---------
Assets
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 25,089 $ 78,849
Accounts receivable, net of allowance
for doubtful accounts of $413 and $644 20,951 12,682
Inventories 10,241 8,828
Deferred income taxes 1,432 1,432
Other current assets 2,596 1,351
--------- ---------
Total current assets 60,309 103,142
Property and equipment, net 6,342 3,760
Acquired technology, goodwill and other intangibles, net 8,682 --
Notes receivable from employees 3,473 --
Other assets 1,076 186
--------- ---------
$ 79,882 $ 107,088
========= =========
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of capital lease obligations and long-term debt $ 207 $ 167
Accounts payable 2,737 3,954
Accrued liabilities 8,903 5,150
Deferred revenue 530 353
--------- ---------
Total current liabilities 12,377 9,624
--------- ---------
Capital lease obligations and long-term debt 320 241
--------- ---------
Deferred income taxes 12 12
--------- ---------
Shareholders' equity:
Preferred stock, $0.01 par value; 5,000,000 shares authorized;
none issued and outstanding -- --
Common stock, $0.01 par value; 40,000,000 shares authorized; 28,629,000 and
25,597,000 shares issued and outstanding 286 257
Additional paid-in capital 119,999 89,772
Notes receivable from shareholders -- (301)
Deferred compensation related to stock options (272) (334)
Cumulative translation adjustment (100) 4
Retained earnings (accumulated deficit) (52,740) 7,813
--------- ---------
Total shareholders' equity 67,173 97,211
--------- ---------
$ 79,882 $ 107,088
========= =========
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
1
<PAGE>
<TABLE>
CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data; unaudited)
<CAPTION>
Three Months Ended Nine Months Ended
----------------------------- -----------------------------
September 26, September 27, September 26, September 27,
1997 1996 1997 1996
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenue $ 20,560 $ 15,021 $ 55,011 $ 35,790
Cost of revenue 7,251 6,193 18,973 15,024
-------- -------- -------- --------
Gross profit 13,309 8,828 36,038 20,766
-------- -------- -------- --------
Operating expenses:
Research and development, net 4,326 2,774 12,113 8,413
Selling and marketing 5,851 3,415 15,514 9,531
General and administrative 2,499 1,671 6,708 4,332
Purchased in-process technology 63,920 -- 63,920 --
-------- -------- -------- --------
Total operating expenses 76,596 7,860 98,255 22,276
-------- -------- -------- --------
Income (loss) from operations (63,287) 968 (62,217) (1,510)
Other income (expense):
Interest income, net 663 1,003 2,479 2,302
Royalty and other income (expense), net 76 67 518 (237)
-------- -------- -------- --------
Income (loss) before income taxes (62,548) 2,038 (59,220) 555
Provision for income taxes 335 693 1,333 189
-------- -------- -------- --------
Net income (loss)
$(62,883) $ 1,345 $(60,553) $ 366
======== ======== ======== ========
Net income (loss) per share $ (2.37) $ 0.05 $ (2.32) $ 0.01
======== ======== ======== ========
Shares used to compute net income (loss)
per share 26,514 26,886 26,046 25,308
======== ======== ======== ========
<FN>
See accompanying notes to Condensed Consolidated Financial Statements.
</FN>
</TABLE>
2
<PAGE>
<TABLE>
CYLINK CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands; unaudited)
<CAPTION>
Nine Months Ended
---------------------------
September 26, September 27,
1997 1996
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income (loss) $(60,553) $ 366
Adjustments to reconcile net income (loss) to net cash used in operating
activities:
Purchased in-process technology 63,920 --
Depreciation and amortization 1,614 980
Realized loss on sale of securities -- 432
Deferred compensation related to stock options 62 63
Deferred income taxes -- 147
Changes in assets and liabilities (net of effects of
Algorithmic Research purchase):
Accounts receivable (7,286) (6,528)
Inventories (990) (2,258)
Other assets (921) (196)
Accounts payable (1,397) 2,254
Accrued liabilities 1,606 990
Deferred revenue (8) (120)
-------- --------
Net cash used in operating activities (3,953) (3,870)
Cash flows from investing activities:
Proceeds from sale of short-term investments -- 2,844
Acquisition of property and equipment (2,803) (1,454)
Purchase of Algorithmic Research, net of cash acquired (44,350) --
Loans to employees in exchange for notes receivable (3,473) --
-------- --------
Net cash provided buy (used in) investing activities (50,626) 1,390
-------- --------
Cash flows from financing activities:
Proceeds from issuance of common stock, net 731 79,786
Payment of notes receivable from shareholders 301 100
Repayment of capital lease obligations and long-term debt (109) (238)
Repayment of borrowings under bank line of credit -- (1,000)
-------- --------
Net cash provided by financing activities 923 78,648
-------- --------
Effect of exchange rate changes on cash and cash equivalents (104) 4
-------- --------
Net increase (decrease) in cash and cash equivalents (53,760) 76,172
Cash and cash equivalents at beginning of period 78,849 3,240
-------- --------
Cash and cash equivalents at end of period $ 25,089 $ 79,412
======== ========
Supplemental disclosures:
Cash paid for income taxes $ 31 $ --
Cash paid for interest 78 95
Equipment acquired under capital lease obligations -- 247
Equity issued and liabilities incurred for
purchase of Algorithmic Research 30,056 --
<FN>
See accompanying notes to Condensed Consolidated Financial Statements
</FN>
</TABLE>
3
<PAGE>
CYLINK CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Basis of Presentation
The unaudited condensed consolidated financial statements included
herein contain all adjustments, consisting only of normal recurring
adjustments which, in the opinion of management, are necessary to fairly
state the consolidated financial position, results of operations and cash
flows of Cylink Corporation ("Cylink" or the "Company") for the periods
presented. These financial statements should be read in conjunction with
the Company's audited financial statements included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1996. Interim results
of operations are not necessarily indicative of the results to be expected
for the full year.
2. Acquisition of Algorithmic Research
On September 8, 1997, the Company acquired all of the outstanding
shares of Algorithmic Research, Ltd. and Algart Holdings, Ltd. (hereafter
referred to on a combined basis as "Algorithmic Research"), both limited
liability companies organized under the laws of the State of Israel.
Algorithmic Research is an information security company providing remote
access software products and smart-card technology focusing on the market
for Internet-based (TCP/IP) communications. Algorithmic Research also
provides security products to broadcast networks. Consideration for this
purchase was $44,881,000 in cash, net of cash acquired, including
transaction expenses paid and accrued of $2,996,000 and $531,000,
respectively; and 2,593,169 shares of the Company's common stock and
409,641 fully vested options to purchase common stock of the Company for
$0.01 per share. The total value placed on the common stock and options
issued by the Company was $29,525,000. The common stock and options issued
are subject to decreasing restrictions on trading and exercise,
respectively, for three years from the transaction date.
The acquisition was recorded under the purchase method of accounting;
and accordingly, the results of operations of Algorithmic Research are
included in the consolidated financial statements from the date of
acquisition. The purchase price has been allocated to the assets acquired
and liabilities assumed based upon the fair market values at the date of
acquisition, as summarized below (in thousands):
Current assets (including cash and cash equivalents of $1,857) $ 4,380
Property and equipment 1,261
In-process technology 63,920
Developed technology and other intangibles 7,498
Goodwill 1,317
Other non-current assets 96
Current liabilities assumed (2,021)
Long-term debt assumed (188)
-------
$76,263
=======
The amounts allocated to technology were estimated using a risk
adjusted income approach applied to specifically identified technologies.
In-process technology was expensed upon acquisition because technological
feasibility had not been established and no alternative future uses
existed. Amounts allocated to capitalized intangibles other than goodwill
are being amortized on a straight-line basis over three years.
Goodwill is being amortized on a straight-line basis over seven years.
The following unaudited pro forma financial information gives effect to
the acquisition as if it had occurred on January 1, 1996, excluding the
charge related to purchased in-process technology. These pro forma results
have been prepared for comparative purposes only and do not purport to be
indicative of the operations which actually would have resulted had the
acquisition occurred on the date indicated, or which may result in the
future.
4
<PAGE>
<TABLE>
<CAPTION>
Nine Months
Year Ended Ended
December 31, September 26,
1996 1997
-------- --------
(in thousands, except per share data)
<S> <C> <C>
Revenue $ 59,164 $ 59,222
Net income (loss) (1,943) 869
Net income (loss) per share (0.07) 0.03
Shares used to compute net income (loss) per share 27,187 29,621
</TABLE>
3. Notes Receivable From Employees
Pursuant to their employment agreements and related promissory notes,
during the first quarter of 1997 the Company loaned certain employees
$3,473,000 towards the purchase of their principal residences. Of this
amount, $2,843,000 is receivable from officers of the Company. The notes
are interest free and are due five years from the dates of the related
notes, at which time the notes must be repaid or convert into, and become
subject to, the terms of a standard, interest-bearing commercial loan. The
notes are secured by deeds of trust on the residences. The loan agreements
provide for accelerated payment in the event of termination of employment
under certain conditions and, in one instance, under certain circumstances
will be forgiven to the extent of any decrease in the value of the related
residence.
4. Inventory
September 26, December 31,
1997 1996
------- -------
(in thousands)
Raw materials $ 4,552 $ 4,126
Work in process and subassemblies 2,494 3,196
Finished goods 3,195 1,506
$10,241 $ 8,828
======= =======
<TABLE>
5. Recent Accounting Pronouncement
In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 128 ("FAS 128"),
"Earnings Per Share." This statement redefines earnings per share under
generally accepted accounting principles. Under the new standard, primary
earnings per share is replaced by basic earnings per share and fully
diluted earnings per share is replaced by diluted earnings per share. The
Company is required to adopt the new standard in the fourth quarter of
1997. The following table sets forth net income (loss) per share as
reported and unaudited pro forma basic and diluted net income (loss) per
share assuming FAS 128 had been applied during the periods presented:
<CAPTION>
Three Months Ended Nine Months Ended
------------------------------ ------------------------------
September 26, September 27, September 26, September 27,
1997 1996 1997 1996
-------- -------- --------- ----
<S> <C> <C> <C> <C>
Net income (loss) per share as reported $ (2.37) $ 0.05 $ (2.32) 0.01
Pro forma basic net income (loss) per share (2.37) 0.05 (2.32) 0.02
Pro forma diluted net income (loss) per share (2.37) 0.05 (2.32) 0.01
</TABLE>
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 130 ("FAS 130"), "Reporting Comprehensive Income." FAS 130
establishes standards for reporting comprehensive income and its components
in a financial statement that is displayed with the same prominence as
other financial statements. Comprehensive income as defined includes all
changes in equity (net assets) during a period from nonowner
5
<PAGE>
sources. Examples of items to be included in comprehensive income, which
are excluded from net income, include foreign currency translation
adjustments and unrealized gain/loss on available for sale securities. The
disclosure prescribed by FAS 130 must be made beginning with the first
quarter of 1998.
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131 ("FAS 131"), "Disclosures about Segments of an Enterprise
and Related Information." This statement establishes standards for the way
companies report information about operating segments in annual financial
statements. It also establishes standards for related disclosures about
products and services, geographic areas, and major customers. The Company
has not yet determined the impact of adopting this new standard. The
disclosures prescribed by FAS 131 are effective for 1998.
6
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
The statements contained in this Report on Form 10-Q that are not
purely historical are forward-looking statements within the meaning of Section
27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act
of 1934, including statements regarding Cylink's expectations, hopes,
intentions, beliefs or strategies regarding the future. Forward-looking
statements include: the Company's statements in Part I, Item 2 "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
regarding the sufficiency of the Company's existing liquidity and capital
resources, management's belief that resolution of certain litigation described
in Part II, Item 1 "Legal Proceedings" will not have a material adverse effect
on the Company's financial position and results of operations, the Company's
expectation that it will introduce a number of new products in 1997 and continue
to make a significant investment in engineering, research and development, and
its intention to expand its foreign sales channels and enter additional
international markets. All forward-looking statements included in this document
are based on information available to the Company as of the date of this Report
on Form 10-Q, and the Company assumes no obligation to update any such
forward-looking statements, or to update the reasons why actual results could
differ from those projected in the forward-looking statements. It is important
to note that the Company's actual results could differ materially from those in
such forward-looking statements for the reasons detailed in "Risk Factors That
May Affect Future Results" and other sections of this Report on Form 10-Q. You
should also consult the risk factors listed from time to time in the Company's
Reports on Form 10-Q, 8-K, 10-K and Annual Reports to the Shareholders.
BUSINESS ACQUISITION
On September 8, 1997, the Company acquired Algorithmic Research, an
Israeli company. Algorithmic Research is an information security company
providing remote access network security products and smart-card technology
focusing on the market for Internet-based (TCP/IP) communications. Algorithmic
Research also provides security products to broadcast networks. See Note 2 of
Notes to Condensed Consolidated Financial Statements. The total acquisition
price of approximately $76.3 million was funded from a combination of the
Company's existing working capital, newly issued common stock and options to
purchase common stock. Approximately $63.9 million of the total purchase price
represented the value of in-process technology that had not yet reached
technological feasibility, had no alternative future uses and was charged to the
Company's operations in the third quarter ended September 26, 1997. The
amortization of capitalized intangibles and the charge resulting from in-process
technology are not deductible for income tax purposes. The acquisition was
accounted for under the purchase method of accounting; and accordingly, the
results of operations of Algorithmic Research are included in the consolidated
financial statements from the date of acquisition.
RESULTS OF OPERATIONS
Revenue. The Company's revenue is derived primarily from sales of its
family of commercial information security products and its medium speed spread
spectrum radio products. Fees for maintenance and support services are charged
separately. Revenue from product sales is recognized upon shipment to the
customer. Concurrently, a provision is made for estimated costs to repair or
replace products under warranty arrangements. Revenue from sales to distributors
is recognized upon shipment; no right of return, stock rotation or price
protection is given. Revenue from sales to value added resellers is recognized
upon shipment and concurrently a provision for estimated returns is recorded.
The Company's revenue increased by 37% from $15.0 million for the three
months ended September 27, 1996 to $20.6 million for the three months ended
September 26, 1997, and increased by 54% from $35.8 million for the nine months
ended September 27, 1996 to $55.0 million for the nine months ended September
26, 1997. Sales of information security products increased by 75% from $7.5
million for the third quarter of 1996 to $13.1 million for the third quarter of
1997, and increased by 96% from $17.3 million for the first nine months of 1996
to $34.1 million for the first nine months of 1997. The increase in information
security product revenue resulted primarily from significantly increased product
shipments in the SecureWan and SecureLan encryption product lines, which are
used in public and private linked networks. Overall average selling prices for
information security products decreased marginally. Information security product
revenue for the third quarter of 1997 includes $1.1 million attributable to
Algorithmic Research. Sales of wireless communications products were $7.5
million for both the third quarter of 1996 and 1997. Increased shipments of
wireless communications products were offset by decreases in overall average
selling prices. Wireless communications revenue increased 14% from $18.4 million
for the first nine
7
<PAGE>
months of 1996 to $20.9 million for the first nine months of 1997. This increase
was primarily due to higher unit sales, particularly for the Company's AirLink
S-Band radios and AirLink T1/E1 products, partially offset by a decrease in
average selling prices.
International revenue was 58% and 54% of total revenue for the third
quarter of 1996 and 1997, respectively, and was 56% and 52% of total revenue for
the first nine months of 1996 and 1997, respectively. The decrease in
international product revenue as a percentage of total revenue from 1996 to 1997
was due primarily to the increased percentage of total revenue represented by
information security products, which are sold mostly in the United States.
Gross Profit. Gross profit increased by 51% from $8.8 million for the
three months ended September 27, 1996 to $13.3 million for the three months
ended September 26, 1997, and increased by 74% from $20.8 million for the nine
months ended September 27, 1996 to $36.0 million for the nine months ended
September 26, 1997. The increase in dollars was primarily a result of the
significant increase in revenue. As a percentage of sales, gross profit was 59%
and 65% for the third quarter of 1996 and 1997, respectively, and 58% and 66%
for the first nine months of 1996 and 1997, respectively. The increase in gross
margin resulted from the increased percentage of total revenue represented by
information security products, which generally have higher gross margins than
wireless communications products. In addition, the increase in gross margin was
due to lower average unit costs for both wireless communications and information
security products, and a decrease in expenses for maintenance and support
services related to the Company's information security products.
Research and Development. Research and development expenses consist
primarily of salaries and other personnel related expenses, depreciation of
development equipment, facilities and supplies. Gross research and development
expenses decreased 2% from $4.4 million for the three months ended September 27,
1996 to $4.3 million for the three months ended September 26, 1997, and
increased 7% from $12.3 million for the nine months ended September 27, 1996 to
$13.2 million for the nine months ended September 26, 1997. Gross research and
development expenses as a percentage of revenue were 29% and 21% for the third
quarter of 1996 and 1997, respectively, and 34% and 24% for the first nine
months of 1996 and 1997, respectively. The dollar increase for the nine months
ended September 26, 1997 compared to the same period last year resulted from the
Company's expanded product development efforts, partially offset by reduced
contract and other variable expenses related to externally funded research and
development. From time to time the Company receives engineering funding for
development of projects to apply or enhance the Company's technology to a
particular customer's need. The amounts recognized under these research and
development contracts are offset against research and development expenses. No
engineering funding was recognized during the third quarter of 1997. Amounts
recognized under non-recurring engineering contracts totaled $1.6 million for
the third quarter of 1996, and $3.9 million and $1.1 million for the first nine
months of 1996 and 1997, respectively.
Selling and Marketing. Selling and marketing expenses consist primarily
of personnel expenses, including sales commissions, and expenses for
advertising, public relations, seminars and trade shows. Selling and marketing
expenses increased 71% from $3.4 million for the three months ended September
27, 1996 to $5.8 million for the three months ended September 26, 1997, and
increased 63% from $9.5 million for the nine months ended September 27, 1996 to
$15.5 million for the nine months ended September 26, 1997. Selling and
marketing expenses as a percentage of revenue were 23% and 28% for the third
quarter of 1996 and 1997, respectively, and 27% and 28% for the first nine
months of 1996 and 1997, respectively. The dollar increases were due to expenses
associated with expansion of the Company's direct sales force, personnel
increases in the marketing group, and increased expenses associated with
advertising, public relations and trade shows.
General and Administrative. General and administrative expenses consist
primarily of personnel and related costs, recruitment expenses, information
systems costs, and audit, legal and other professional service fees. General and
administrative expenses increased 50% from $1.7 million for the three months
ended September 27, 1996 to $2.5 million for the three months ended September
26, 1997, and 55% from $4.3 million for the nine months ended September 27, 1996
to $6.7 million for the nine months ended September 26, 1997. General and
administrative expenses as a percentage of revenue were 11% and 12% for the
third quarter of 1996 and 1997, respectively, and were 12% for both the nine
months ended 1996 and 1997. The dollar increases were primarily due to increased
staffing and professional fees necessary to manage and support the Company's
recent growth. General and administrative expenses for the third quarter of 1997
include approximately $132,000 of amortization expense related to intangible
assets resulting from the acquisition of Algorithmic Research. In subsequent
quarters, this amortization will be approximately $675,000.
8
<PAGE>
Other Income (Expense), Net. Other income (expense), net, primarily
consists of royalties, interest income, interest expense and investment gains
and losses. Interest income, net, increased from $2.3 million for the first nine
months of 1996 to $2.5 million for the first nine months of 1997, principally
due to interest income resulting from funds derived from the Company's initial
public offering in February and March of 1996. Interest income, net, decreased
from $1.0 million for the third quarter of 1996 to $663,000 for the third
quarter of 1997 due to cash used for the acquisition of Algorithmic Research. In
the first quarter of 1997, the Company recorded a benefit of $632,000 primarily
related to the reversal of an allowance provided on the receivable related to
the Company's interest in the residual value of a former partnership known as
Public Key Partners ("PKP"). Management considers the uncertainty regarding
ultimate collection to have been resolved as a result of the settlement
agreement between the Company and RSA Data Security, Inc., a subsidiary of
Security Dynamics ("RSA DSI"). The assets of the former partnership, consisting
primarily of cash, are being held in trust pending the resolution of certain
litigation described in Part II, Item 1 "Legal Proceedings." Management does not
believe that the ultimate resolution of this matter will have a material adverse
effect on the Company's financial position or results of operations. The first
quarter of 1996 includes a $441,000 write down of the Company's short-term
investments as management concluded the decline in value was permanent. These
investments were sold at an actual loss of $432,000 in the third quarter of
1996. The Company also experienced a decline in royalty income during the nine
months ended September 27, 1997 as compared to the same period in 1996.
LIQUIDITY AND CAPITAL RESOURCES
At September 26, 1997, the Company had cash and cash equivalents of
$25.1 million, working capital of $47.9 million and minimal long-term
obligations. For the nine months ended September 26, 1997, the Company recorded
a net loss of $60.6 million due to a nonrecurring charge for in-process
technology related to the acquisition of Algorithmic Research. Net cash used in
operating activities for the nine month period ended September 26, 1997 of $4.0
million consisted primarily of increases in current assets other than cash and a
decrease in accounts payable, partially offset by an increase in accrued
liabilities.
Cash used in investing activities for the nine months ended September
26, 1997 was $50.6 million, of which $44.4 million was attributed to the
acquisition of Algorithmic Research. The Company also made expenditures for
property and equipment of $2.8 million and provided long-term loans to employees
of $3.5 million.
The Company is currently engaged in litigation and has certain assets
subject to litigation. See Part II, Item 1 "Legal Proceedings." Management
believes that the ultimate resolution of these matters will not have a material
adverse effect on the Company's financial position or results of operations.
The Company believes that existing cash balances and cash generated
from operations, if any, will be sufficient to fund necessary purchases of
capital equipment and to provide working capital through at least the remainder
of 1997. However, the Company may require additional funds to support its
working capital requirements or for other purposes and may seek to raise such
additional funds through public or private equity financing or from other
sources. No assurance can be given that additional financing will be available
or that, if available, will be available on terms favorable to the Company or
its shareholders.
RISK FACTORS THAT MAY AFFECT FUTURE RESULTS
Recent Losses; Potential Fluctuations in Operating Results, Future Operating
Results Uncertain.
Due primarily to increased research and development, sales and
marketing, and litigation expenses, the Company incurred losses in 1994 and 1995
and the first six months of 1996. The Company also incurred a loss in the third
quarter of 1997 due to expenses resulting from the acquisition of Algorithmic
Research. There can be no assurances that the Company will increase or maintain
its revenue or be profitable on a quarterly or an annual basis in the future.
The Company has historically experienced significant fluctuations in
its operating results on an annual and a quarterly basis and could experience
such fluctuations in the future. The Company's operating results are affected by
a number of factors, many of which are outside of the Company's control,
including: the timing of the introduction of new or enhanced products by the
Company or its competitors; market acceptance of new products of the Company,
its customers and its competitors; the timing, cancellation or delay of customer
orders, including cancellation or
9
<PAGE>
delay in anticipation of new product introduction or enhancement; competitive
factors, including pricing pressures; changes in operating expenses, including
those resulting from changes in available production capacity of independent
foundries and other suppliers and the availability of raw materials; expenses
associated with obtaining, enforcing and defending claims with respect to
intellectual property rights, and the effect of any such claims on customer
acceptance of Company products; the mix of products sold; changes in the
percentage of products sold through the Company's direct sales force; personnel
changes; general economic conditions; and fluctuations in foreign currency
exchange rates. The Company expects to introduce a number of new products in
1997. The failure of such new products to achieve market acceptance at the time
anticipated by the Company, or at all, would materially and adversely affect the
Company's financial condition and results of operations.
Potential Volatility of Stock Price
The trading of the Company's Common Stock has been and may continue to
be subject to wide fluctuations in response to quarter to quarter variations in
operating results, announcements of technological innovations or new products by
the Company or its competitors, developments with respect to patents or
proprietary rights, general conditions in the information security systems and
wireless communications industries, changes in earnings estimates by analysts,
or other events or factors. In addition, the stock market has experienced
extreme price and volume fluctuations, which have particularly affected the
market prices of many technology companies and which have often been unrelated
to the operating performance of such companies. The Company's sales or operating
results in future quarters may be below the expectations of public market
securities analysts and investors. In such event, the price of the Company's
Common Stock would likely decline, perhaps substantially. These Company-specific
factors or broad market fluctuations may have a material adverse effect on the
market price of the Company's Common Stock.
Pending Litigation
See Part II, Item 1. "Legal Proceedings."
Dependence on Key Personnel
The Company's future success will depend to a large extent on the
abilities and successful contributions of its executive officers, key management
and technical personnel. The Company has been able to recruit several senior
managers in the last year and its future is closely linked to the ability to
successfully integrate these key employees into the Company, and to maintain and
extend its base of talented management, technical and other personnel.
Competition for highly-skilled business, product development, technical and
other personnel is intense, and the loss of the services of one or more of the
Company's executive officers or key personnel, or the inability to continue to
attract qualified personnel, could delay product development cycles or otherwise
have a material adverse effect on the Company's financial position and results
of operations.
Lengthy Sales Cycle
Sales of the Company's products generally involve a significant
commitment of capital by customers, with the attendant delays frequently
associated with large capital expenditures. For these and other reasons, the
sales cycle associated with the Company's products is typically lengthy and
subject to a number of significant risks over which the Company has little or no
control. The Company is often required to ship products shortly after it
receives orders and, consequently, order backlog at the beginning of any period
has in the past represented only a small portion of that period's expected
revenue. As a result, product revenue in any period is substantially dependent
on orders booked and shipped in that period. The Company typically plans its
production and inventory levels based on internal forecasts of customer demand,
which are highly unpredictable and can fluctuate substantially. If revenue falls
significantly below anticipated levels, the Company's financial condition and
results of operations would be materially and adversely affected. In addition,
the Company's operating expenses are based on anticipated revenue levels and a
high percentage of the Company's expenses are generally fixed in the short term.
Based on these factors, a small fluctuation in the timing of sales can cause
operating results to vary significantly from period to period. In addition, it
is possible that in the future the Company's operating results will be below the
expectations of securities analysts and investors. In such an event, or in the
event that adverse conditions prevail or are perceived to prevail generally or
with respect to the Company's business, the price of the Company's Common Stock
would likely be materially adversely affected.
10
<PAGE>
Dependence on Recently Introduced and New Information Security Products
The Company's future results of operations will be highly dependent on
the successful completion of the design, development, introduction, marketing
and manufacture of the SecureManager and PrivateSafe products, some of which are
under development, and the SecureGate, SecureFrame, SecureDomain and PrivateWire
products, which were recently introduced. To date, the Company has made only
limited commercial shipments of certain of such products. No assurance can be
given that any of such products will not require additional development work,
enhancement, testing or further refinement before they can be introduced and
made commercially available by the Company or that they will achieve market
acceptance. If such new and recently introduced products have performance,
reliability, quality or other shortcomings, then such products could fail to
achieve market acceptance and the Company may experience reduced orders, higher
manufacturing costs, delays in collecting accounts receivable and additional
warranty and service expenses, which in each case could have a material adverse
effect on the Company's financial condition and results of operations.
Competition
Competition is intense among providers of information security systems
and wireless communications equipment and systems, and the Company expects such
competition to increase in the future. Significant competitive factors in these
markets include the development of new products and features, product quality
and performance, the quality and experience of sales, marketing and service
organizations, product price and name recognition. Many of these factors are
beyond the Company's control.
The Company's competitors in the information security markets include
Security Dynamics, Semaphore, Cray Research, Racal-Guardata, Inc. and
Information Resource Engineering, Inc. Northern Telecom Limited, AT&T, Motorola
Corporation, Digital Equipment Corporation and Sun Microsystems, Inc. offer
certain information security products as part of their overall networking
solutions. In addition, a number of significant vendors, including Microsoft
Corporation, Netscape Communications Corporation and Cisco Systems have embedded
security solutions in their software. Other vendors, notably Checkpoint, Raptor,
Trusted Information Systems, and others, offer a technology known as firewalls,
which is often perceived by customers as an adequate security solution obviating
a need for the Company's products. To the extent that these embedded or optional
security capabilities provide all or a portion of the functionality provided by
the Company's products, the Company's products may no longer be required by
customers to attain information security.
Several vendors including Certicom and RSA DSI license various methods
of implementing cryptographic technology, including some that are different than
(and incompatible with) the method of implementing cryptography currently used
by the Company in most of its products. Although Cylink has a license to use all
of the leading methods promoted by the Company, Certicom and RSA DSI, to the
extent relevant industries impose technical standards different than those
currently used by the Company in any segment of the information security market,
sales of the Company's existing and planned products in that market segment may
be adversely impacted, which could have a material adverse effect on the
Company's financial condition and results of operations.
The Company competes with a large number of companies in the wireless
communications markets, including U.S. local exchange carriers and foreign
telephone companies. The most significant competition for sub-T1 rate AirLink
products in the wireless market is from telephone companies that offer leased
line data services. The Company also competes with other suppliers of wireless
products such as Digital Wireless, Utilicom, Western Multiplex and California
Microwave, Inc.
Many of the Company's competitors have substantially greater financial,
technical, marketing, distribution and other resources, greater name recognition
and longer standing relationships with customers than the Company. Competitors
with greater financial resources are better able to engage in sustained price
reductions in order to gain market share. Any period of sustained price
reductions would have a material adverse effect on the Company's financial
condition and results of operations. There can be no assurance that the Company
will be able to compete successfully in the future or that competitive pressures
will not materially and adversely affect the Company's financial condition and
results of operations.
Product Liability Risks
Customers rely on the Company's information security products to
prevent unauthorized access to their networks and data transmissions. A
malfunction or the inadequate design of the Company's products could result in
11
<PAGE>
tort or warranty claims. Although the Company seeks to reduce the risk of such
losses by attempting to negotiate warranty disclaimers and liability limitation
clauses in its sales agreements and by maintaining product liability insurance,
there can be no assurance that such measures will be effective in limiting the
Company's liability for any such damages. Any liability for damages resulting
from security breaches could be substantial and could have a material adverse
effect on the Company's business and results of operations. In addition, a
well-publicized actual or perceived security breach could adversely affect the
market's perception of security products in general, or the Company's products
in particular, regardless of whether such breach is attributable to the
Company's products. This could result in a decline in demand for the Company's
products, which would have a material adverse effect on the Company's financial
condition and results of operations.
Management of Growth
The Company has recently experienced and may continue to experience
substantial growth in the number of its employees and the scope of its
operations, resulting in increased responsibilities for management. To manage
growth effectively, the Company will need to continue to improve its
operational, financial and management information systems and to hire, train,
motivate and manage a growing number of employees. Competition is intense for
qualified technical, marketing and management personnel, particularly highly
skilled engineers. In particular, the current availability of qualified
engineers is quite limited, and competition among companies, academic
institutions, government entities and other organizations for skilled and
experienced engineering personnel is very intense. The Company is currently
attempting to hire a number of engineering personnel and has experienced delays
in filling such positions. The Company expects to experience continued
difficulty in filling its needs for qualified engineers and other personnel.
There can be no assurance that the Company will be able to effectively achieve
or manage any future growth, and its failure to do so could delay product
development cycles or otherwise have a material adverse effect on the Company's
financial condition and results of operations.
Intellectual Property and Other Proprietary Rights
The Company relies on patents, trademarks, copyrights, licenses and
trade secret law to establish and preserve its intellectual property rights. The
Company owns twelve U.S. patents covering certain aspects of its product designs
and has one additional U.S. patent application pending. There can be no
assurance that any patent, trademark, copyright or license owned or held by the
Company will not be invalidated, circumvented or challenged, that the rights
granted thereunder will provide competitive advantages to the Company or that
any of the Company's pending or future patent applications will be issued with
the scope of the claims sought by the Company, if at all. Further, there can be
no assurance that others will not develop technologies that are similar or
superior to the Company's technology, duplicate the Company's technology or
design around the patents owned by the Company. The Company may be subject to or
may initiate interference proceedings in the U.S. Patent Office, which can
require significant financial and management resources. In addition, the laws of
certain countries in which the Company's products are or may be developed,
manufactured or sold may not protect the Company's products and intellectual
property rights to the same extent as the laws of the United States. The
inability of the Company to protect its intellectual property adequately could
have a material adverse effect on its financial condition and results of
operations.
The Company incorporates in its products cryptographic technology
described in certain fundamental patents to public key crytography owned by
Stanford University (the "Stanford Patents") which expired in the United States
in September and October, 1997. Consequently, this basic technology is now
freely available for use by the Company's competitors and customers. To the
extent the Company's competitors are successful in duplicating or reverse
engineering the Company's know how in commercializing this technology, the
customer's demand for the Company's products may be adversely affected.
The network information security and wireless communications industries
in which the Company sells its products are characterized by substantial
litigation regarding patent and other intellectual property rights. From time to
time, the Company has received communications from third parties asserting that
the Company's patents, features or content of certain of the Company's products
infringe upon the intellectual property rights held by third parties, and the
Company may receive such communications in the future. The Company is not aware
that any of the features or content of its products wrongfully infringe on any
valid intellectual property rights of others. There can be no assurance that
third parties will not assert claims against the Company that result in
litigation. Any litigation, whether or not determined in favor of the Company,
could result in significant expense to the Company and could divert management
and other resources. In the event of an adverse ruling in any litigation
involving intellectual property, the Company might be required to discontinue
the use of certain processes, cease the manufacture, use and sale of infringing
products, expend significant resources to develop non-infringing technology or
obtain licenses to the infringing technology and may suffer significant monetary
damages, which could include treble damages. There can be no assurance that
under such circumstances a license would be available to the Company on
reasonable terms or at all. In the event of a successful claim against the
Company and the Company's failure to develop or license a substitute technology
on commercially reasonable terms, the Company's financial condition and results
of operations would be adversely affected. There can be no assurance that
existing claims or any other assertions (or claims for
12
<PAGE>
indemnity from customers resulting from infringement claims) will not materially
and adversely affect the Company's financial condition and results of
operations.
Evolving Information Security Market
The market for the Company's information security products is only
beginning to emerge. This market is characterized by rapidly changing
technology, emerging industry standards, new product introductions and changes
in customer requirements and preferences. The Company's future success will
depend in part upon end users' demand for information security products in
general, and upon the Company's ability to enhance its existing products and to
develop and introduce new products and technologies that meet customer
requirements. Any significant advance in technologies for attacking
cryptographic systems could render some or all of the Company's existing and new
products obsolete or unmarketable. To the extent that a specific method other
than the Company's is adopted as the standard for implementing information
security in any segment of the information security market, sales of the
Company's existing and planned products in that market segment may be adversely
impacted, which could have a material adverse effect on the Company's financial
condition and results of operations. There can be no assurance that information
security-related products or technologies developed by others will not adversely
affect the Company's competitive position or render its products or technologies
noncompetitive or obsolete.
In addition, a portion of the sales of the Company's information
security products will depend upon a robust industry and infrastructure for
providing access to public switched networks, such as the Internet. There can be
no assurance that the infrastructure or complementary products necessary to make
these networks into viable commercial marketplaces will be developed, or, if
developed, that these networks will become viable commercial marketplaces.
Rapid Technological Change
The markets for the Company's products are characterized by rapidly
changing technologies, extensive research and new product introductions. The
Company believes that its future success will depend in part upon its ability to
continue to enhance its existing products and to develop, manufacture and market
new products. As a result, the Company expects to continue to make a significant
investment in engineering, research and development. There can be no assurance
that the Company will be able to develop and introduce new products or
enhancements to its existing products in a timely manner which satisfy customer
needs, achieve market acceptance or address technological changes in its target
markets. The failure of the Company to develop products and introduce them
successfully and in a timely manner could adversely affect the Company's
competitive position, financial condition and results of operations.
Wireless Communications Industry Regulatory Environment
Wireless communications are subject to regulations by United States and
foreign laws and international treaties. In the United States, the Company's
wireless communications products are subject to various regulations of the
Federal Communications Commission ("FCC"). Current FCC regulations permit
license-free operation of certain FCC certified wireless products. The future of
remote wireless communications is highly volatile, due in part to ongoing
uncertainty regarding telecommunications deregulation and the status of
initiatives relating to the auction of licenses for personal communications
service ("PCS") frequencies. Regulatory changes, including changes in the
allocation of available frequencies, could significantly affect the Company's
operations by diverting the Company's development efforts, making current
products obsolete or increasing the opportunity for additional competition.
There can be no assurance that new regulations will not be promulgated which
could have a material adverse effect on the Company's financial condition and
results of operations.
The Company also is subject to regulatory requirements in foreign
markets. Equipment can be marketed in a country only if permitted by suitable
frequency allocations and regulations, and only if such equipment has received
type approval by the country in question. The process of complying with new
regulations and of obtaining type approval is often complex and lengthy and can
result in significant expense and delays in the introduction of products in new
countries.
Changes in, or the failure by the Company to comply with, applicable
domestic and international regulations could have a material adverse effect on
the Company's business and operating results. There can be no assurance that the
Company will be able to comply with regulations in any particular country.
13
<PAGE>
Risks Associated with International Sales; Reliance Upon Local Partners.
International product sales represented approximately 35%, 47%, 59% and
52% of revenue in 1994, 1995, 1996 and for the nine months ended September 26,
1997, respectively. In particular, sales of the Company's wireless
communications products are currently concentrated in developing countries. The
Company plans to continue to expand its foreign sales channels and to enter
additional international markets, both of which will require significant
management attention and financial resources. International sales are subject to
a number of risks, including unexpected changes in regulatory requirements,
tariffs and other trade barriers, political and economic instability in foreign
markets, difficulties in the staffing, management and integration of foreign
operations, longer payment cycles, greater difficulty in collecting accounts
receivable, currency fluctuations and potentially adverse tax consequences.
Since most of the Company's foreign sales are denominated in U.S. dollars, the
Company's products become less price competitive in countries in which local
currencies decline in value relative to the U.S. dollar. The uncertainty of
monetary exchange values has caused, and may in the future cause, some foreign
customers to delay new orders or delay payment for existing orders. The
long-term impact of such devaluation, including any possible effect on the
business outlook in other developing countries, cannot be predicted.
The Company's ability to compete successfully in foreign countries is
dependent in part on the Company's ability to obtain and retain reliable and
experienced in-country distributors and other strategic partners. The Company
does not have long-term relationships with any of its value added resellers and
distributors and, therefore, has no assurance of a continuing relationship
within a given market.
Risks Associated with Regulation Over Information Security Products
United States government regulations restrict the export of certain
cryptographic devices, including certain of the Company's information security
products. As a result, the Company may be at a disadvantage in competing for
international sales compared to companies located outside the United States that
are not subject to such restrictions. In addition, international customers may
be unwilling to purchase the Company's products which are eligible for export
due to perceptions that such products are inferior to those marketed within the
United States, may contain undocumented features which undermine the products'
security architecture, or are required to incorporate security features which
are unacceptable to the customer. Furthermore, the regime of export
administration, and resulting regulations in the United States are in a stage of
transition due to political controversy concerning their purposes and legality.
Consequently, the uncertainty concerning the interpretation and application of
such regulations may unduly delay or prevent the export of Company products,
leading to a commensurate loss of revenue and market position.
Recent legislative proposals have indicated the possibility that
Company products sold for use within the United States may be required to
incorporate certain features to assist law enforcement agencies in recovering
suspect communications. In the event such proposals are enacted into law, the
Company may be obligated to expend considerable sums in complying with such
regulations. In addition, the market opportunities and customer acceptance of
the Company's products may be adversely affected by the Company's compliance
with such laws, leading to a commensurate loss of revenue and market share.
Dependence on Component Availability, Subcontractor Performance and Key
Suppliers
The Company's ability to timely deliver its products is dependent upon
the availability of quality components and subsystems used in these products.
The Company depends in part upon subcontractors to manufacture, assemble and
deliver certain items in a timely and satisfactory manner. The Company obtains
certain components and subsystems from single, or a limited number of, sources.
A significant interruption in the delivery of such items could have a material
adverse effect on the Company's financial condition and results of operations.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On March 7, 1997, ten former employees of the Company filed suit in
action No. CV764647 in the Superior Court of California, County of Santa Clara,
against the Company, each of its Directors and its General Counsel, asserting
claims for wrongful termination, fraud, libel, slander, age discrimination,
invasion of privacy, and violation of the federal RICO statute. After removing
the action to the United States District Court, Northern District of California,
the court dismissed the libel and RICO claims against all defendants, the fraud
claims against all outside directors, and remanded the action back to the state
Superior Court. On July 23, 1997, one additional former employee served a
summons and complaint in action No. CV767448 in the Superior Court of
California, County of Santa Clara, against the Company and one additional
defendant alleging grounds similar to those asserted by the ten pending
plaintiffs. Discovery in both actions has been initiated and trial of either or
both actions is not expected before late 1998 or early 1999. Although the
Company has placed its insurers on notice of these claims, only some of them
have admitted coverage with reservation of certain rights and defenses. The
Company believes the terminations were lawful and intends to defend the matter
vigorously. The defense of this matter may divert a material amount of
management's attention and require the expenditure of significant legal fees and
costs. An unfavorable outcome which exceeds the Company's insurance coverage, if
any, could also result in a material adverse effect on the Company's financial
condition.
14
<PAGE>
On September 6, 1995, the Company obtained an arbitration award
dissolving a former partnership, known as PKP, between the Company's
wholly-owned subsidiary, Caro-Kann Corporation, and RSA DSI. The only remaining
claim against PKP, which was dismissed in September 1997 in action C-94-20512 SW
before the United States District Court for the Northern District of California
is presently an appeal by a third party plaintiff. An unfavorable outcome on the
appeal, and a subsequent verdict in favor of the plaintiff of trial, might
affect the residual value the Company may receive from the former partnership.
Item 2. Changes in Securities
(c) The Company's Registration Statement Form S-1 was declared effective by
the Securities and Exchange Commission on February 15, 1996 (Reg. No.
33-80719). In February and March 1996 the Company issued 5,750,000 shares
of its common stock to the public at a price of $15 per share. The Company
received approximately $78.9 million net of underwriting discounts and
commissions of $6.0 million and other offering expenses of $1.4 million.
Through the period ended September 26, 1997, the net proceeds have been
used as follows (in thousands):
Purchase and installation of equipment $ 5,618
Acquisition of Algorithmic Research 45,913
Repayment of indebtedness 1,000
Working capital 5,854
Temporary investment in money market accounts 20,479
-------
$78,864
=======
None of the net proceeds or expenses of issuance and distribution of
the securities have been, either directly or indirectly, paid to or
invested with any related party or shareholder of the Company.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits Index:
Exhibit
Number Description of Exhibit
------ ----------------------
27.1 Financial Data Schedule
(b) The Company filed a report on Form 8-K on September 23, 1997 reporting
under Item 2 the acquisition of Algorithmic Research effective September 8,
1997.
15
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Date: November 10, 1997 CYLINK CORPORATION
By: /s/ JOHN H. DAWS
-------------------------------
John H. Daws
Vice President of Finance
and Administration and
Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
16
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